8/17/19
Statistical
Summary
Current Economic Forecast
2018 estimates (revised)
Real Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2%
Corporate Profits 10-15%
2019
Real Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2.5%
Corporate Profits 5-6%
Current Market Forecast
Dow Jones Industrial Average
Current Trend (revised):
Short Term Uptrend 23490-33730
Intermediate Term Uptrend 14513-30732
(?)
Long Term Uptrend 6849-30311(?)
2018
Year End Fair Value 13800-14000
2019 Year End Fair Value
14500-14700
Standard & Poor’s 500
Current
Trend (revised):
Short Term Uptrend 2569-3468
Intermediate
Term Uptrend 1383-3193
(?) Long Term Uptrend 937-3217 (?)
2018 Year End Fair Value 1700-1720
2019 Year End Fair Value 1790-1810
Percentage
Cash in Our Portfolios
Dividend Growth Portfolio 56%
High Yield Portfolio 55%
Aggressive Growth Portfolio 56%
Economics/Politics
The Trump economy is a neutral for equity
valuations. The data this week was mixed: above estimates:
weekly mortgage and purchase applications, the August housing market index, July
retail sales, the August Philadelphia and NY Fed manufacturing indices, June
business inventories/sales, preliminary Q2 nonfarm productivity and unit labor
costs; below estimates: weekly jobless claims, month to date retail chain store sales, August
consumer sentiment, July industrial production, the July small business
optimism index, July import/export prices, July core CPI; in line with
estimates: July housing starts/building permits, the July budget deficit July
CPI.
However, the primary indicators were a
plus: July retail sales (+), preliminary Q2 nonfarm productivity (+), July housing
starts/building permits (0), July industrial production (-). I am rating this week a positive. Score: in the last 200 weeks, sixty-six
positive, ninety negative and forty-four neutral.
This is the second upbeat week in a
row for the numbers---though admittedly both were just barely so. While not a
trend yet, two more weeks of improvement and I will turn off the flashing
yellow warning light. Two notes:
(1)
as you know, much was made this week of the yield curve
inversion and it implications for a recession.
However, there usually a long lead time between a yield curve inversion
and the onset of a recession; and as some analysts have argued in this narrative’s
links, there are instances of no recession.
So, if I turn off the flashing yellow light, I am just going with the
dataflow which doesn’t mean that conditions won’t deteriorate later on,
(2)
nevertheless, the economy continues to grow, sluggish
as it may be, in the face of the US/China trade war and the rest of world’s
economies seemingly rolling over. I have
said before and I will say it again, the US economy possesses the best managers
and hardest working labor force on the planet which have allowed it to slowly
improve in spite of totally irresponsible monetary and fiscal policies. Can it do the same with the aforementioned
added burdens? So far, so good.
Overseas, the stats continue to run negative
though Europe was a bright spot---a 180 from last week. Still, not that helpful for our own economy.
[a] Q2
German flash GDP was in line but negative while July German CPI was in line but
PPI was disappointing; Q2 UK productivity fell but was in line, May jobs growth
and retail sales accelerated; July UK CPI, core CPI, PPI and core PPI were
above forecasts; Q2 EU GDP growth was in line but employment rose less than
consensus; June EU industrial production and August economic sentiment were
below projections; the June EU trade balance was positive,
Is Germany about to commence deficit
spending?
[b] June
Chinese vehicle sales, fixed asset investments, industrial production, retail
sales and July outstanding loan growth were below estimates,
[c] July
Japanese machine tool orders were below expectations while machinery orders and
industrial production were above; July PPI was lower than anticipated.
Developments this week that impact the economy:
(1) trade:
the main headline this week was Trump removing some products from the scheduled
September ten percent tariff hike and delaying the increase for other items
until December [Christmas related products].
I covered this development in Wednesday’s Morning Call, so I will only
repeat my takeaways:
[a] the Chinese offered little in return,
confirming my opinion that they will almost certainly make no serious
concessions until after November 2020, if then.
To be fair, they did send some mixed messages on Thursday. One saying that there would be no agreement,
period; and the other suggesting that there might be some wiggle room to
compromise on US treatment of Huawei.
This doesn’t alter my opinion,
[b] while I grudging agree with Trump’s
action; he really just kicked the can down the road to save Christmas sales. However, there is plenty of speculation that
he was, at least in part, trying to halt the decline in the stock market, again
demonstrating that he judges his success as president by the level of the
Market---which, in and of itself, is not a wise measure. That in turn suggests that he is much more
likely to fold before the 2020 elections if the Market is not behaving
positively---which would {i} leave the Chinese free to continue their unfair
trade practices for the long term and {ii} make all the economic agony that the
global economy has had to endure during the US/China trade dispute for naught.
[c] whatever Trump ultimately
does, negative
headlines are in our future. If he
folds, the economy will improve short term but the long term economic growth
prospects are negative. If he hangs
tough, the economy will continue to experience a short term drag on growth but
the longer term outlook improves.
That, of course, assumes that the Chinese won’t fold [which I
believe that they won’t]. If they do,
then both short and long term growth forecasts will be much brighter.
(2) fiscal
policy: I haven’t ranted about our totally
irresponsible fiscal policy of late; but this week’s release of the July budget
deficit occasions me to remind you that the US is running $1 trillion plus annual
budget deficits at, what appears to be, the peak of an economic cycle. Furthermore, it is increasing the national debt at a time when
it already has a debt to GDP ratio in excess of 90%---which studies have marked
as the point at which the debt becomes a burden to the economy, inhibiting its
growth.
To whom does the US government owe money?
(3) monetary
policy: little of substance this week.
Though there appears to be a growing belief that the central banks have
lost their control of interest rates to the Markets. The risk of this becoming generally accepted
is that the notion that the central banks/Fed have the Markets’ back becomes
null and void. While that may have
little impact on economic growth [which I have maintained that they never had
in the first place], it will almost surely affect the current central
bank/Fed/Market co-dependency.
Another must read from Jeffrey Snider.
(4) global
hotspots. the Middle East hostility remains contained but the buildup of
military hardware in the Persian Gulf is not a plus. The bad news is that the threat of violence
remains which if it occurs could lead to severe economic consequences in a
worst case scenario. Remember a large percentage of global oil supplies
transits the Straits of Hormuz, which is bordered on one side by Iran. Any military action that would choke off
those supplies would be a negative for the global economy.
Unfortunately, the number of global trouble
spots is growing:
[a] the unrest in Hong Kong; while
ostensively a battle over Hong Kong government’s right to deport troublemakers
to the Chinese mainland, it has become intermeshed with the US/China trade skirmish
in that the Chinese are accusing the US of interference,
[b] Italy is again on the verge of
political/economic collapse. By itself,
I don’t consider that a big problem; but to the extent that it would cause
disruptions in the EU banking system, it could precipitate a much larger
problem. And nothing says extra pressure like a hard
‘Brexit’,
[c] North Korea keeps firing off
rockets. Like Hong Kong, this is likely
tied into the US/China standoff {China encourages Kim to make trouble} making
the whole China trade, Hong Kong riots, North Korean missile testing just a big
pot of love stew,
[d] Japan and South Korea are in their own
version of a trade war,
[e] the Brexit deadline is approaching and it
looks a like a no-deal Brexit is the highest probability outcome,
[f] Argentina appears to be headed back to Peronism
which has precipitated a crash in its currency and bond markets. By itself, any damage would likely be
localized; but with global bond markets in flux, it is adding fuel to a growing
level of uncertainty.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average rate. The principal cause of the restraint being totally
irresponsible fiscal (running monstrous deficits at full employment adding to
too much debt) and monetary (pushing liquidity into the financial system that
has done little to help the economy but has led to the gross mispricing and
misallocation of assets) policies.
Cyclically, the US economy continues to limp
along which is not surprising given the lethargic global economy and the
continuing threat of trade wars. Indeed,
this progress is a miracle given all the aforementioned fiscal and monetary
headwinds. That said, the yellow warning
light is still flashing.
The
Market-Disciplined Investing
Technical
The Averages (25886,
2888) made a strong follow through to
Thursday’s bounce. But volume was down
and breadth was mixed---which reminds me that rallies can be quite strong in a
down Market (both indices are building very short term downtrends). The
Dow ended below its 100 DMA (now resistance) and above its 200 DMA (now support;
voiding Wednesday’s break). The S&P ended below its 100 DMA for a third day
(I am now calling it resistance) and above its 200 DMA (now support). Very short term, both indices intraday bounced
off their August 5th low. So
that is a level to watch.
The VIX fell 12 ¾ %,
but still finished above both MA’s (now support) and continues to build a very short
term uptrend. So, it lends a negative
bias to equities.
The long bond was down
7/8 %, but remained above both MA’s, in uptrends across all timeframes. However, it is getting very overextended on a
short term basis. So, barring really bad
economic/political news, a correction seems likely.
Treasury
considering issuing 50 to 100 year bonds.
Forget the yield curve, it is the
lack of liquidity that poses the problem (must read).
The dollar was up,
ending in short and long term uptrends and above both MA’s.
Gold fell 5/8%, but
closed within very short term and short term uptrends and above both MA’s. However, it still has last Friday’s gap up
open which needs to be closed. And like TLT,
it is getting very overbought on a short term basis.
Bottom line: long term, the
Averages are in uptrends across all timeframes; so, the assumption is that they
will continue to advance. Short term, they
are in a range between (1) their 100 DMA and 200 DMA and (2) the upper boundaries
of developing very short term downtrends and their August 5th
lows. So, we now have multiple levels
from which to derive directional information.
Still, they remain well above the lower boundary of their short term
uptrends (23490, 2568). So, the indices could fall a lot further
without breaking their long term upward momentum.
The pin action in the long bond, the
dollar and gold continues to point at the need for a safety trade.
Friday in the charts.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA and the S&P are well above ‘Fair
Value’ (as calculated by our Valuation Model), the improved regulatory
environment and the potential pluses from trade notwithstanding. At the moment, the important factors bearing
on Fair Value (corporate profitability and the rate at which it is discounted)
are:
(1)
the extent to which the economy is growing. The economy continues to struggle forward against
multiple headwinds. As you know, the
dataflow over the last couple of months has raised my concerns that it may
ultimately succumb to these forces---to such an extent that I started the
yellow warning light flashing. Not helping
matters is the recent surge in bond, dollar and gold prices; all of which point
to a flight to safety.
On the other hand, the improvement in the
dataflow over the last two weeks provides some hope that the US can skate
through the current global malaise without a downturn.
Counterpoint.
My sluggish growth
forecast is a neutral but that could change if the stats deteriorate further.
(2)
the [lack of] success of current trade
negotiations. If Trump can create a
fairer political/trade regime, it would almost surely be constructive for
secular earnings growth.
However, that ain’t
happenin’, Indeed, the only progress to
date has been Trump’s actions the week to reverse the scheduled imposition of
tariffs on some items and delay them on [Christmas related] others.
As you know, I
believe that the Chinese will not even consider making any compromise before
the 2020 elections, if ever. So, the
magnitude of this quarrel will likely continue to be determined by Trump’s
actions. If he wants to get more
contentious, it will and vice versa. To
be clear, I still believe that what he is doing is the right course for the
economic long term. But short term, pain
is the word. The only question is how
much.
The process of de-globalization
(must read):
(3)
the resumption of QE by the global central banks. That is now occurring worldwide. This week, the ECB is made a lot of noise about
a new big dose of QE; and the US bond market is pricing in multiple cuts in the
Fed Funds rate this year.
I have maintained for some time that the key
to the Market is monetary policy, more specifically, its co-dependency with the
Fed. But this week, investors appeared
to begin to question their faith in the central banks’ ability to navigate the
global economy through what is now a very trying economic climate. While I am not suggesting a change the
paradigm of central bank/stock market co-dependency, the risk is heightening
that this could occur.
(4)
current valuations. I believe that Averages are grossly
overvalued [as determined by my Valuation Model].
At the moment, [a] the US economic numbers
are not that great, the global stats are worse and, absent a US/China trade
deal, are not apt to get better---all of which augurs poorly for corporate
profits; though to be fair, Q2 earnings season was better than expected, [b]
long term interest rates are falling, suggesting that a weaker economy, and
perhaps even recession, may be in our future, and yet [c] equity prices are a
short hair away from their all-time highs.
The only explanation that I have for this is in
the context that the global central banks are all in on their support of equity
markets. For the last decade, they have measured their success by the
performance of the stock Market, acted accordingly and been victorious. As long as that is the paradigm, fundamental
economics and valuations will likely remain irrelevant. But as I noted above, that may be changing.
As prices continue to rise, I will be primarily
focused on those stocks that trade into their Sell Half Range and act
accordingly. However, there are certain segments of the economy/Market that
have been punished severely (e.g. health care) with the stocks of the companies
serving those industries down 30-70%. I
am compiling a list of potential Buy candidates that can be bought on any
correction in the Market; even a minor one.
As you know, I recently added AbbVie to the Dividend Growth and High
Yield Buy Lists.
Bottom line: fiscal policy is negatively
impacting the E in P/E. On the other
hand, a new regulatory environment is a plus.
Any improvement in our trade regime with China should have a positive
impact on secular growth and, hence, equity valuations---if it occurs. More important, a global central bank ‘put’ has
returned and, if history is any guide, will almost assuredly be a plus for stock
prices.
As a reminder, my Portfolio’s cash
position didn’t reach its current level as a result of the Valuation Models
estimate of Fair Value for the Averages.
Rather I apply it to each stock in my Portfolio and when a stock reaches
its Sell Half Range (overvalued), I reduce the size of that holding. That forces me to recognize a portion of the
profit of a successful investment and, just as important, build a reserve to
buy stocks cheaply when the inevitable decline occurs.
